Contents

Contents
About the Author ......................................................................................................................... iii
How to Use This Manual .............................................................................................................. v

Part 1 Introduction

Chapter 1
Introduction to Bank Capital Management
Why Is Capital So Important?................................................................................................ 1 1
Regulators.......................................................................................................................... 1 2
The Basel Accord........................................................................................................... 1 2
Bank Failures................................................................................................................. 1 2
Going Forward............................................................................................................... 1 3
Shareholders....................................................................................................................... 1 3
Management....................................................................................................................... 1 3
Risk-Adjusted Return on Capital................................................................................... 1 4
Capital and Dividend Policies and Procedures....................................................................... 1 4
Exhibit 1.1: Capital Policy Compliance Checklist......................................................... 1 5
Exhibit 1.2: Dividend Policy Compliance Checklist...................................................... 1 6
Appendix 1A: Sample Capital Planning Policy...................................................................... 1 7
Appendix 1B: Capital Planning Procedures......................................................................... 1 23
Appendix 1C: Dividend Planning Policy............................................................................. 1 33
Appendix 1D: Dividend Planning Procedures...................................................................... 1 36

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Part 2 Capital Allocation and Profitability Management

Chapter 2
Measuring Performance Risk Against Capital:
Risk-Adjusted Performance Measures
Measuring Bank Performance................................................................................................ 2 1
Return on Assets Is Insufficient.......................................................................................... 2 1
Return on Capital Replaces Return on Assets as a Measure of Profitability....................... 2 2
ROE for the Entire Bank................................................................................................ 2 3
ROE for Individual Businesses Within the Bank............................................................ 2 3
Risk-Adjusted Capital Measures............................................................................................ 2 4
What Is RAROC?............................................................................................................... 2 4
Shareholder Value.............................................................................................................. 2 5
Risk and Volatility.............................................................................................................. 2 7
Comparing Volatility from Investments......................................................................... 2 7
Risk and Capital............................................................................................................... 2 11
Risk and Return................................................................................................................ 2 12
What Is a Hurdle Rate?........................................................................................................ 2 13
Determining and Using Hurdle Rates................................................................................... 2 14
Setting Hurdle Rates Relative to Peers............................................................................. 2 14
Using the Capital Asset Pricing Model to Set Target ROE............................................... 2 15
CAPM Applied to Banks.............................................................................................. 2 16
Business Line Hurdle Rates............................................................................................. 2 17
The Value of Hurdle Rates by Business Line............................................................... 2 17
Using the Bank Hurdle Rate......................................................................................... 2 17
Compensating for Different Business Risks................................................................. 2 18
Setting Hurdle Rates by Business................................................................................ 2 20
Setting Higher Hurdle Rates for Some Business Lines................................................ 2 20
Meeting Hurdle Rate Expectations Over Time............................................................. 2 21
Viewing Profitability Using Hurdle Rates............................................................................ 2 22
How Risk-Adjusted Return on Capital Is Calculated........................................................... 2 24
Other Benefits of RAROC................................................................................................... 2 25
Customer Profitability...................................................................................................... 2 26
Product Pricing................................................................................................................. 2 28
Summary.............................................................................................................................. 2 30

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Chapter 3
Introduction to Capital Allocation
Bank Business Lines.............................................................................................................. 3 1
Typical Business Line Units............................................................................................... 3 2
The Business Line Matrix.................................................................................................. 3 3
For What Do We Allocate Capital?........................................................................................ 3 3
Expected and Unexpected Losses...................................................................................... 3 4
Expected/Unexpected Losses: An Example................................................................... 3 4
Categories of Risk.............................................................................................................. 3 5
Allocated Capital vs. Book Capital.................................................................................... 3 7
Allocated Capital vs. Regulatory Capital........................................................................... 3 7
Using Risk-Based Capital Requirements to Allocate Capital............................................. 3 8
Applying Statistics to Capital Allocation............................................................................... 3 8
Statistics 101...................................................................................................................... 3 9
Distributions................................................................................................................... 3 9
Standard Deviations (Sigma)....................................................................................... 3 10
Skewed Data................................................................................................................ 3 12
Excess Capital.................................................................................................................. 3 13
Managing Excess Capital................................................................................................. 3 14
Decrease Your Capital.................................................................................................. 3 14
Increase Your Risk....................................................................................................... 3 14
Keep the Excess Equity Temporarily........................................................................... 3 14
Keep the Excess Equity Permanently........................................................................... 3 15
Where to Allocate Excess Equity..................................................................................... 3 15
Scale Allocations to Actual.......................................................................................... 3 15
Capital Management Unit............................................................................................ 3 16
Guidelines for Capital Allocation......................................................................................... 3 17
Five Universal Commandments for Capital Allocation.................................................... 3 17
Five Institution-Specific Capital Allocation Questions.................................................... 3 18
Summary.............................................................................................................................. 3 19

Chapter 4
Allocating Capital for Credit Risk
Review of Capital Allocation Concepts as Applied to Credit Risk......................................... 4 1
Expected vs. Unexpected Losses........................................................................................ 4 2
An Example of Expected/Unexpected Losses................................................................ 4 3
Loan Portfolios vs. Individual Loans................................................................................. 4 3
Process for Assigning Capital for Commercial Loans............................................................ 4 4
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Risk Rating System............................................................................................................ 4 5

Risk Grades.................................................................................................................... 4 6
Number of Risk Ratings................................................................................................. 4 6
Factors for Assigning Risk Ratings................................................................................ 4 7
The Basel Framework.................................................................................................... 4 7
The Probability of Default of the Borrower................................................................... 4 8
Assessing the Probability of Default.............................................................................. 4 8
The Probability of Loss Given Default.......................................................................... 4 9
Exposure at Time of Default (EAD)............................................................................... 4 9
Determining Expected Losses.......................................................................................... 4 11
Unexpected Losses........................................................................................................... 4 12
Confidence Intervals.................................................................................................... 4 12
Determining Expected Losses and Capital Factors...................................................... 4 13
Converting Data to Capital Allocation......................................................................... 4 14
Process for Assigning Capital for Retail Loans.................................................................... 4 15
Differences Between Commercial and Retail Loans........................................................ 4 15
Estimating Losses from Data........................................................................................... 4 15
Data Segmentation....................................................................................................... 4 16
Product Segmentation.................................................................................................. 4 16
Borrower Segmentation............................................................................................... 4 17
Loan Characteristic Segmentation................................................................................ 4 17
Time Period to Analyze................................................................................................ 4 18
Internal vs. External Data............................................................................................. 4 18
Data Analysis............................................................................................................... 4 18
Portfolio Effects................................................................................................................... 4 19
Summary.............................................................................................................................. 4 19

Chapter 5
Allocating Capital for Interest Rate Risk
and Market Risk
Definition of Interest Rate Risk............................................................................................. 5 1
Types of Core Balance Sheet Interest Rate Risk.................................................................... 5 2
Gap or Mismatch Risk....................................................................................................... 5 2
Basis Risk.......................................................................................................................... 5 3
Yield Curve Twist Risk...................................................................................................... 5 4
Options Risk....................................................................................................................... 5 5
Price Risk........................................................................................................................... 5 6
Securities Classifications............................................................................................... 5 6
Measuring Interest Rate Risk................................................................................................. 5 6
Income Simulation............................................................................................................. 5 7

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Rate Scenarios................................................................................................................ 5 9
Time Horizon............................................................................................................... 5 10
Simulations Issues........................................................................................................ 5 10
Economic Value of Equity................................................................................................ 5 10
Comparing Simulations and Economic Value of Equity Approaches............................... 5 12
Value at Risk (VAR)......................................................................................................... 5 12
Turning Interest Rate Risk Measurement into Capital Allocation........................................ 5 12
Income Simulations as the Basis for Capital Allocation................................................... 5 13
Time Horizon Assumptions.......................................................................................... 5 13
Rate Movement Assumptions....................................................................................... 5 14
Which Rate?................................................................................................................. 5 15
Which Historic Time Period?....................................................................................... 5 16
Economic Value Analysis as the Basis for Capital Allocation.......................................... 5 17
Rate Movement Assumptions....................................................................................... 5 17
Allocating Capital Based on VAR Measures................................................................ 5 17
Who Gets the Interest Rate Risk Capital?............................................................................ 5 18
Allocating Capital for Investment Securities........................................................................ 5 18
Conclusions and Summary................................................................................................... 5 19

Chapter 6
Allocating Capital for Operational and Other Risks
Regulatory Definitions and Issues.......................................................................................... 6 1
Other Risks Identified by the Federal Reserve Board......................................................... 6 1
Other Risks Identified by the Office of the Comptroller of the Currency........................... 6 2
The Basel Committee on Banking Supervisions Definition of Operational Risk.............. 6 5
Examples of Operational and Other Risk............................................................................... 6 6
The Risk of Catastrophic Events........................................................................................ 6 9
Issues in Implementing Capital for Operational and Other Risks......................................... 6 10
Quantification Issues........................................................................................................ 6 10
Lack of Research.............................................................................................................. 6 10
The Predictability of Operational Risk............................................................................. 6 11
Other Issues to Consider................................................................................................... 6 11
Expected vs. Unexpected Losses.................................................................................. 6 11
The Role of Insurance in Covering Operational Losses............................................... 6 11
Offsetting Risks............................................................................................................ 6 11
Conceptual Models for Thinking About Operational Risk................................................... 6 12
Volatile Revenue Flows.................................................................................................... 6 12
Severity vs. Probability.................................................................................................... 6 12
Allocating Capital for Operational Risk: A Three-Step Process........................................... 6 14
Step 1: Estimate the Total Operational Risk Capital Needed for the Bank....................... 6 15
Plug Approach.......................................................................................................... 6 15

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Basel Committee Minimum......................................................................................... 6 15

CAPM Approach.......................................................................................................... 6 16
Step 2: Estimate the Relative Operational Risk of Each Business Line............................ 6 18
Capital for Normal, Painful, and Catastrophic Risks.................................................... 6 18
Basel Committee Method............................................................................................. 6 21
Key Risks Method........................................................................................................ 6 22
Assessing Risk Based on Assets and Expenses............................................................ 6 22
Step 3: Allocate Capital to Business Lines....................................................................... 6 22
Conclusions and Summary................................................................................................... 6 22

Chapter 6A
Managing Operational Risk to Preserve Capital
Defining Operational Risk and Loss.................................................................................... 6A 1
Establishing Loss Prevention as a Goal............................................................................... 6A 2
Strategy for Identifying Operational Risk Factors............................................................... 6A 3
Tracking and Monitoring with KPIs and KRIs................................................................ 6A 4
Basel II AMA Minimum Standards..................................................................................... 6A 4
Estimating Expected and Unexpected Losses.................................................................. 6A 5
Exhibit 6A.1: Planning Worksheet for the Basel II AMA Capital Charge................... 6A 7
Operational Risk Factors, the Business Environment, and Internal Controls................... 6A 8
Identifying KPIs and KRIs.......................................................................................... 6A 9
Exhibit 6A.2: Acceptable and Unacceptable KPIs..................................................... 6A 12
Establishing an Integrated System of Internal Controls............................................. 6A 12
Using Scenario Analyses to Understand Possible Operational Losses and
Loss Events................................................................................................................... 6A 17

Part 3 Regulatory Capital

Chapter 7
Introduction to Regulatory Issues
The Regulators Perspective...................................................................................................
The Function of Capital.....................................................................................................
How Todays Capital Measures Evolved................................................................................
The 1988 Basel Accord......................................................................................................
Evolving Standards............................................................................................................
Current Basel Efforts.....................................................................................................

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Small Bank Exceptions.................................................................................................. 7 3

The Regulatory Evaluation.................................................................................................... 7 4
Risk-Based Capital Standards............................................................................................ 7 4
Risks Not Covered by Risk-Based Capital Measures..................................................... 7 5
Other Ratios....................................................................................................................... 7 6
Equity Capital/Total Assets............................................................................................ 7 7
Equity Growth/Asset Growth......................................................................................... 7 7
Dividends as a Percentage of Income or Operating Income........................................... 7 7
Double Leverage............................................................................................................ 7 7
Capital Adequacy Component of CAMELS Rating........................................................... 7 7
Prompt Corrective Action................................................................................................. 7 11
Summary.............................................................................................................................. 7 11

Chapter 8
Types and Definitions of Regulatory Capital
Types of Capital..................................................................................................................... 8 1
Tier 1 Capital..................................................................................................................... 8 2
Tier 2 Capital..................................................................................................................... 8 3
Common Equity (Tier 1 Capital)........................................................................................ 8 3
Voting vs. Nonvoting Stock........................................................................................... 8 4
Preferred Stock (Tier 1 or Tier 2 Capital)........................................................................... 8 4
Preferred Stock Features That Qualify for Tier 1 Capital............................................... 8 4
Features That Do Not Qualify for Tier 1 Capital............................................................ 8 5
Minority Interest in Equity Accounts of Consolidated Subsidiaries
(Generally, Tier 1 Capital).................................................................................................. 8 7
Allowance for Loan and Lease Losses (Tier 2 or Not Qualified as Capital)....................... 8 9
Net Unrealized Holding Gains (Losses) on Securities Available for Sale.......................... 8 9
Mandatory Convertible Debt Securities (Tier 2 Capital).................................................. 8 10
Subordinated Debt and Intermediate-Term Preferred Stock (Tier 2 Capital).................... 8 12
Term............................................................................................................................. 8 12
Interest Rate................................................................................................................. 8 13
Capital Adjustments............................................................................................................. 8 14
Intangible Assets (Deducted from Tier 1 or Tier 2 Capital).............................................. 8 14
Limits, Sublimits, and Adjustments.............................................................................. 8 15
Review and Monitoring................................................................................................ 8 17
Disallowed Deferred-Tax Assets...................................................................................... 8 18
Investments in Unconsolidated Banking and Finance Subsidiaries and
Other Subsidiaries (Deducted from Total Capital)........................................................... 8 18
Reciprocal Holdings of Banking Organizations Capital Instruments
(Deducted from Total Capital).......................................................................................... 8 19
Nonfinancial Equity Investments (Deducted from Tier 1 Capital)................................... 8 20

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Exclusions.................................................................................................................... 8 21
Summary.............................................................................................................................. 8 22
Appendix 8.1: Primary Regulator: FDIC Regulations Applicable to State
Nonmember Banks............................................................................................................... 8 23

Chapter 9
Asset Risk Weightings
Background............................................................................................................................ 9 1
Risk Weighting Formulas................................................................................................... 9 2
OECD Countries and Central Governments....................................................................... 9 2
OECD Countries............................................................................................................ 9 2
Central Government........................................................................................................... 9 3
Cash, Reserves, and Due from Banks.................................................................................... 9 3
Claims on Depository Institutions.......................................................................................... 9 4
Short-Term Claims on Depository Institutions in OECD Countries................................... 9 5
Claims on Depository Institutions in OECD Countries.................................................. 9 5
Government Claims (U.S., Foreign, and Local Governments)............................................... 9 6
Claims Issued or Guaranteed by the U.S. Government and Agencies................................ 9 6
Assets Guaranteed by U.S. Government and Agencies or Central Government of
OECD Country................................................................................................................... 9 7
Conditionally Guaranteed Government or OECD Assets................................................... 9 7
Federal Reserve Bank Stock............................................................................................... 9 9
Claims Against Central Government of OECD Countries.................................................. 9 9
Claims on States or Other Political Subdivisions............................................................. 9 10
Other Obligations Weighted by Credit Rating...................................................................... 9 11
Mortgages and Mortgage-Backed Securities........................................................................ 9 11
Exhibit 9.1: Mortgage Assets Qualifying for 50 Percent Weight.................................. 9 12
One- to Four-Family Residential Property (Owner-Occupied or Rented)........................ 9 13
Multifamily Residential Loans......................................................................................... 9 13
Construction Loans for Residential Property.................................................................... 9 14
Privately Issued Mortgage-Backed Securities.................................................................. 9 15
Claims on Securities Firms.................................................................................................. 9 16
Accrued Interest................................................................................................................... 9 17
Fixed Assets, Premises, and Other Real Estate..................................................................... 9 17
Other Assets......................................................................................................................... 9 17
Bank-Owned Life Insurance............................................................................................ 9 17
Risk-Based Capital Treatment of BOLI........................................................................... 9 18
Criteria for a Look-Through Approach........................................................................ 9 19
Look-Through Approaches.......................................................................................... 9 19
Sample Calculation...................................................................................................... 9 21
Summary.............................................................................................................................. 9 22

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Appendix 9.1: Primary Regulator: FDIC Regulations Applicable to

State Nonmember Banks...................................................................................................... 9 23

Chapter 10
Off-Balance Sheet Risk Weights
Conversion to Off-Balance Sheet Equivalent....................................................................... 10 2
Risk Assignment.............................................................................................................. 10 4
Contingency Obligations...................................................................................................... 10 4
Letters of Credit............................................................................................................... 10 4
Financial Letters of Credit........................................................................................... 10 5
Performance Letters of Credit...................................................................................... 10 5
Commercial Letters of Credit........................................................................................... 10 5
Bankers Acceptances...................................................................................................... 10 5
Off-Balance Sheet Commitments......................................................................................... 10 5
Forward Agreements........................................................................................................ 10 6
Revolving Underwriting Facilities................................................................................... 10 6
Unused Commitments...................................................................................................... 10 6
Specific Regulatory Interpretations Related to Commitments...................................... 10 7
Sale and Repurchase Agreements..................................................................................... 10 8
Loaned Securities............................................................................................................. 10 8
Participations in Off-Balance Sheet Transactions............................................................. 10 8
Commitments to Make Off-Balance Sheet Transactions.................................................. 10 9
Commitments to Make Letters of Credit...................................................................... 10 9
Commitments to Make Commitments.......................................................................... 10 9
Commitments to Make a Commercial Letter of Credit................................................ 10 9
Derivatives......................................................................................................................... 10 10
Types of Derivative Contracts........................................................................................ 10 10
Exceptions.................................................................................................................. 10 11
Bilateral Netting............................................................................................................. 10 11
Current Exposure........................................................................................................... 10 12
Future Exposure............................................................................................................. 10 13
Resetting Interest Rate Contracts............................................................................... 10 14
Multiple Exchanges of Principal................................................................................ 10 14
Floating/Floating Swaps............................................................................................. 10 14
Capital Treatment of Recourse, Direct Credit Substitutes, and Residual Interests in
Asset Securitizations.......................................................................................................... 10 14
Definitions...................................................................................................................... 10 15
Credit Derivative........................................................................................................ 10 15
Securitization............................................................................................................. 10 15
Recourse.................................................................................................................... 10 16
Residual Interest......................................................................................................... 10 16

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Direct Credit Substitutes............................................................................................ 10 17

Credit-Enhancing Interest-Only Strip......................................................................... 10 17
Credit-Enhancing Representations and Warranties..................................................... 10 17
Credit Equivalent Amount.............................................................................................. 10 18
Risk-Weight Factors....................................................................................................... 10 18
Determining Credit-Equivalent Amounts and Risk Weights........................................... 10 18
Traded Positions......................................................................................................... 10 18
Non-Traded Positions................................................................................................. 10 19
Senior Positions Not Externally Rated....................................................................... 10 20
Conveyed Positions.................................................................................................... 10 20
Direct Credit Substitutes: Risk Participations and Syndications................................ 10 20
Concentration Limit on Credit-Enhancing Interest-Only Strips................................. 10 21
Credit-Enhancing Interest-Only Strip Capital Requirement....................................... 10 21
Other Residual Interests Capital Requirement............................................................ 10 21
Residual Interests and Other Recourse Obligations.................................................... 10 21
Positions Not Rated by an NRSRO............................................................................ 10 22
Assessing an Internal Risk Rating System..................................................................... 10 23
Step-By-Step Decision Tree Examination Procedures................................................ 10 24
Determining the Adequacy of the Institutions Internal Risk Rating System.............. 10 32
Weakest Link Methodology....................................................................................... 10 32
Using Other Methodologies....................................................................................... 10 34
Limitations on Risk-Based Capital Requirements.......................................................... 10 34
Low-Level Exposure Rule......................................................................................... 10 34
Related On-Balance Sheet Assets............................................................................... 10 34
Alternative Capital Calculation for Small Business Obligations.................................... 10 34
Summary............................................................................................................................ 10 35
Exhibit 10.1: Factors Considered in the ABCP Program Underwriting Process......... 10 36
Appendix 10.1: Primary Regulator: FDIC Regulations Applicable to
State Nonmember Banks.................................................................................................... 10 44

Chapter 11
Regulatory Ratios and Prompt Corrective Action
Bank Capital Ratios.............................................................................................................. 11 1
Risk-Based Capital Ratio................................................................................................. 11 4
Tier 1 Capital Ratio.......................................................................................................... 11 5
Leverage Ratio................................................................................................................. 11 5
Tangible Leverage Ratio................................................................................................... 11 5
Bank Holding Company Ratios............................................................................................ 11 6
Feds Revised BHC Rating System.................................................................................. 11 6
Small Bank Holding Company Exception........................................................................ 11 7
Capital Assessment by the Regulators.................................................................................. 11 8

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Reclassifications......................................................................................................... 11 10
Prompt Corrective Action................................................................................................... 11 10
Notification..................................................................................................................... 11 11
Capital Distribution Limits Applied to All Banks........................................................... 11 11
Requirements of Undercapitalized Banks....................................................................... 11 11
Increased Level of Monitoring................................................................................... 11 11
Capital Restoration Plan............................................................................................. 11 12
Deadlines.................................................................................................................... 11 12
Restrictions on Asset Growth..................................................................................... 11 12
Requirements of Critically Undercapitalized Institutions or Undercapitalized
Institutions That Fail to Submit a Capital Restoration Plan........................................ 11 13
Critically Undercapitalized Banks.............................................................................. 11 14
Enforcement of Directives.......................................................................................... 11 15
Other Restrictions........................................................................................................... 11 15
Small Bank Exemption................................................................................................... 11 15
Appendix 11.1.................................................................................................................... 11 16

Chapter 12
Capital for Market Risk
What Banks Are Affected?................................................................................................... 12 1
Exceptions........................................................................................................................ 12 2
Bank Holding Companies................................................................................................ 12 2
What Is Covered?................................................................................................................. 12 2
Covered Positions............................................................................................................ 12 2
Examples of Instruments in the Trading Account............................................................. 12 3
Debt Instruments.......................................................................................................... 12 3
Equity Instruments....................................................................................................... 12 3
Foreign Exchange and Commodities Positions............................................................ 12 3
Adjusted Risk-Based Capital............................................................................................... 12 4
Tier 3 Capital................................................................................................................... 12 4
Tier 3 Capital Limits........................................................................................................ 12 4
Adjusted Risk-Based Assets................................................................................................. 12 4
Market Risk Equivalent Assets......................................................................................... 12 5
Capital Ratio Requirement............................................................................................... 12 5
Measuring Market Risk........................................................................................................ 12 5
Value at Risk.................................................................................................................... 12 5
The VAR Risk-Based Capital Charge........................................................................... 12 6
Multiplication Factor Based on Back-Testing Results.................................................. 12 7
Specific Risk Add-On...................................................................................................... 12 7
Debt Instruments.......................................................................................................... 12 8
Equity Positions........................................................................................................... 12 8

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Other Factors in Market Risk Assessment............................................................................ 12 9

Elements of a Sound Internal Analysis of Capital Adequacy....................................... 12 9
Assessing the Risk Management Model..................................................................... 12 10
Regulatory Data Requirements for Market Risk Assessment............................................. 12 10
National Trust Banks.......................................................................................................... 12 11
Board Responsibilities.................................................................................................... 12 12
Regulatory Review......................................................................................................... 12 12
Summary............................................................................................................................ 12 14
Appendix 12.1.................................................................................................................... 12 15

Chapter 12A
The New Capital Guidelines:
Basel II and Its Impact on Bank Capital Regulation
Basel I............................................................................................................................... 12A 2
What Did Basel I Do?.................................................................................................... 12A 3
Concept of Required Capital Based on Risk-Weighted Assets Introduced................ 12A 3
Two Tiers of Capital.................................................................................................. 12A 4
FDICIA and PCA...................................................................................................... 12A 4
What Was Wrong with Basel I?................................................................................. 12A 5
Basel II.............................................................................................................................. 12A 6
The Proposed U.S. Adoption of Basel II........................................................................ 12A 6
Quantitative Impact Studies....................................................................................... 12A 6
The Basel II Approach................................................................................................... 12A 7
To Whom Does Basel II Apply?.................................................................................... 12A 8
The Three Pillars............................................................................................................... 12A 9
Pillar 1: Minimum Regulatory Capital Requirements.................................................... 12A 9
Capital Definition...................................................................................................... 12A 9
Credit Risk.............................................................................................................. 12A 10
Operational Risk...................................................................................................... 12A 12
Trading Risk............................................................................................................ 12A 13
Pillar II: Supervisory Review...................................................................................... 12A 13
Pillar III: Market Discipline......................................................................................... 12A 14
Time Frame for Implementation...................................................................................... 12A 14
Coordination of Implementation.................................................................................. 12A 16
What Does This Mean for U.S. Banks?........................................................................... 12A 16
Impact of FDICIA and PCA........................................................................................ 12A 16
Bifurcation................................................................................................................... 12A 17
Impact on Commercial Lending at Banks of Different Sizes....................................... 12A 17
Other Disproportionate Impacts................................................................................... 12A 18
Impact on Consolidation of the U.S. Banking Industry............................................... 12A 19

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Opting In..................................................................................................................... 12A 20

Foreign Subsidiaries.................................................................................................... 12A 20
Capital Change Caps................................................................................................... 12A 21
Is the U.S. Implementation Consistent with the Goal of Bringing Internal
Capital Allocation into Line with Regulatory Capital Requirements?......................... 12A 21
Detailed Analysis of the Minimum Capital Requirement and Market
Discipline Pillars............................................................................................................. 12A 22
Credit Risk Details in Pillar I....................................................................................... 12A 22
Standard Approach.................................................................................................. 12A 22
Internal Ratings-Based Approaches......................................................................... 12A 22
Operational Risk Details in Pillar II............................................................................. 12A 24
Market Discipline Details in Pillar III.......................................................................... 12A 24
Disclosure Requirements....................................................................................... 12A 24a
Additional Resources................................................................................................. 12A 24b
BIS Publications.................................................................................................... 12A 24d
Exhibit 12A.1: Risk-Based Capital Guidelines; Implementation of New Basel
Capital Accord....................................................................................................... 12A 24f
Exhibit 12A.2: Draft Supervisory Guidance on Internal Ratings-Based Systems
for Corporate Credit.............................................................................................. 12A 175
Exhibit 12A.3: Supervisory Guidance on Operational Risk Advance Measurement
Approaches for Regulatory Capital....................................................................... 12A 257

Part 4 Practical Issues in Capital Management

Chapter 13
Practical Issues in Capital Management
Regulatory Perspective........................................................................................................ 13 1
Shareholders Perspective.................................................................................................... 13 3
The Internal Perspective....................................................................................................... 13 5
Deriving Value from RAROC.......................................................................................... 13 5
RAROC Success Factors and Pitfalls........................................................................... 13 5
Peer Analysis.................................................................................................................... 13 7
The Capital Planning Function......................................................................................... 13 7
A Look to the Future............................................................................................................ 13 8
Summary.............................................................................................................................. 13 9
Regulatory........................................................................................................................ 13 9
Shareholders Perspective................................................................................................. 13 9
Internal Perspective........................................................................................................ 13 10
Peer Analysis.................................................................................................................. 13 10
Capital Planning............................................................................................................. 13 10

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The Future...................................................................................................................... 13 11
Exhibit 13.1: UBPR Peer Group Ratio Distribution Report for 3/31/2005 for
All Insured Commercial Banks in Peer Group 004 Capital Analysis
Percentile Ranks......................................................................................................... 13 12
Exhibit 13.2: UBPR Peer Group Data for All Insured Groups in Peer Group 007..... 13 13
Exhibit 13.3: Capital Analysis XYX Bank, Anytown, USA....................................... 13 14
Exhibit 13.4: Capital Planning Model........................................................................ 13 16
Exhibit 13.5: Bank Capital Planning with the Equity Multiplier................................ 13 17

Part 5 Peer Analysis

Excel Peer Analysis Charts
Appendix
Glossary and Formulas

Regulatory References
12 CFR Pt. 225 (Code of Federal Regulations, Title 12, Chapter 2, Part 225)
Bank Holding Companies and Change in Bank Control (Regulation Y)
Appendix A to Part 225 Capital Adequacy Guidelines for Bank Holding
Companies: Risk-Based Measure.................................................................................... RR 1
12 CFR Pt. 225 (Code of Federal Regulations, Title 12, Chapter 2, Part 225)
Bank Holding Companies and Change in Bank Control (Regulation Y)
Appendix B to Part 225 Capital Adequacy Guidelines for Bank Holding
Companies and State Member Banks: Leverage Measure.......................................... RR 67
12 CFR Pt. 225 (Code of Federal Regulations, Title 12, Chapter 2, Part 225)
Bank Holding Companies and Change in Bank Control (Regulation Y)
Appendix C to Part 225 Small Bank Holding Company Policy Statement........... RR 81
12 CFR Pt. 225 (Code of Federal Regulations, Title 12, Chapter 2, Part 225)
Bank Holding Companies and Change in Bank Control (Regulation Y)
Appendix D to Part 225 Capital Adequacy Guidelines for Bank Holding
Companies: Tier 1 Leverage Measure........................................................................... RR 85
12 CFR Pt. 225 (Code of Federal Regulations, Title 12, Chapter 2, Part 225)
Bank Holding Companies and Change in Bank Control (Regulation Y)

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Appendix E to Part 225 Capital Adequacy Guidelines for Bank Holding

Companies: Market Risk Measure................................................................................ RR 89
12 CFR Pt. 325 (Code of Federal Regulations, Title 12, Chapter 3, Part 325)
Capital Maintenance
Subpart A Minimum Capital Requirements.......................................................... RR 101
12 CFR Pt. 325 (Code of Federal Regulations, Title 12, Chapter 3, Part 325)
Capital Maintenance
Subpart B Prompt Corrective Action..................................................................... RR 121
12 CFR Pt. 325 (Code of Federal Regulations, Title 12, Chapter 3, Part 325)
Capital Maintenance
Appendix A to Part 325 Statement of Policy on Risk-Based Capital.................... RR 133
12 CFR Pt. 325 (Code of Federal Regulations, Title 12, Chapter 3, Part 325)
Capital Maintenance
Appendix B to Part 325 Statement of Policy on Capital Adequacy...................... RR 193
12 CFR Pt. 325 (Code of Federal Regulations, Title 12, Chapter 3, Part 325)
Capital Maintenance
Appendix C to Part 325 Risk-Based Capital for State Non-Member
Banks: Market Risk...................................................................................................... RR 203
Federal Deposit Insurance Act
Section 38 Prompt Corrective Action..................................................................... RR 215
12 CFR Pt. 3 (Code of Federal Regulations, Title 12, Chapter 1, Part 3)
Minimum Capital Ratios; Issuance of Directives....................................................... RR 239
12 CFR Pt. 3 (Code of Federal Regulations, Title 12, Chapter 1, Part 3)
Appendix A to Part 3 Risk-Based Capital Guidelines........................................... RR 253
12 CFR Pt. 3 (Code of Federal Regulations, Title 12, Chapter 1, Part 3)
Appendix B to Part 3 Market Risk Adjustment.................................................... RR 303
12 CFR Pt. 6 (Code of Federal Regulations, Title 12, Chapter 1, Part 6)
Prompt Corrective Action............................................................................................ RR 315
12 CFR Pt. 208 (Code of Federal Regulations, Title 12, Chapter 2, Part 208)
Membership of State Banking Institutions in the Federal Reserve System
(Regulation H)
Sections 208.40 through 208.45.................................................................................... RR 329
12 CFR Pt. 208 (Code of Federal Regulations, Title 12, Chapter 2, Part 208)
Membership of State Banking Institutions in the Federal Reserve System
(Regulation H)
Appendix A to Part 208 Capital Adequacy Guidelines for State Member
Banks: Risk-Based Measure........................................................................................ RR 339
12 CFR Pt. 208 (Code of Federal Regulations, Title 12, Chapter 2, Part 208)
Membership of State Banking Institutions in the Federal Reserve System
(Regulation H)
Appendix B to Part 208 Capital Adequacy Guidelines for State Member
Banks: Tier 1 Leverage Measure................................................................................. RR 401
12 CFR Pt. 208 (Code of Federal Regulations, Title 12, Chapter 2, Part 208)
Membership of State Banking Institutions in the Federal Reserve System
(Regulation H)

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Appendix E to Part 208 Capital Adequacy Guidelines for State Member

Banks: Market Risk Measure...................................................................................... RR 405
12 CFRPt. 327 (Code of Federal Regulations, Title 12, Chapter 3, Part 327)
Assessments................................................................................................................... RR 417
12 CFR Pt. 337 (Code of Federal Regulations, Title 12, Chapter 3, Part 337)
Unsafe and Unsound Banking Practices
Section 337.6 Brokered Deposits............................................................................. RR 445
12 CFR Pt. 337 (Code of Federal Regulations, Title 12, Chapter 3, Part 337)
Unsafe and Unsound Banking Practices
Section 337.3 Limits on Extension of Credit to Executive Officers, Directors,
and Principal Shareholders of Insured Nonmember Banks...................................... RR 451
12 CFR Pt. 362 (Code of Federal Regulations, Title 12, Chapter 3, Part 362)
Activities and Investment of Insured State Banks
Subpart E Financial Subsidiaries of Insured State Nonmember Banks.............. RR 455
12 CFR Pt. 206 (Code of Federal Regulations, Title 12, Chapter 2, Part 206)
Limitations on Interbank Liabilities (Regulation F).................................................. RR 461
12 CFR Pt. 201 (Code of Federal Regulations, Title 12, Chapter 2, Part 201)
Extensions of Credit by Federal Reserve Banks (Regulation A)
(as amended effective January 9, 2003)....................................................................... RR 471
12 CFR 1828 (United States Code, Title 12, Chapter 16, Section 1828)
Regulations Governing Insured Depository Institutions............................................ RR 481
FR Pt. 208 (Code of Federal Regulations, Title 12, Chapter 2, Part 208)
Membership of State Banking Institutions in the Federal Reserve System
(Regulation H)
Section 208.5 Dividends and Other Distributions....................................................... RR 507
69 FR 43996 (Federal Register, July 23,2004)
Bank Holding Company Rating System...................................................................... RR 509

User Guide
System Requirements............................................................................................. User Guide 1
To Use on a PC...................................................................................................... User Guide 2
To Use on an Intranet............................................................................................. User Guide 2
Using the Peer Analysis Excel Charts.................................................................... User Guide 2
Using the Linked Table of Contents....................................................................... User Guide 3

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